Why Is Apple One of the Cheapest Stocks in the Market?

We might be barely two months into 2013, but the market has already rallied by 7% since the start of the New Year. Gains in the market come in spite of anemic earnings growth. Companies are still reporting results for the final quarter of 2012, but it looks like earnings growth should clock in at less than 1% across 2012. That means companies' share prices are soaring with little earnings growth and P/E multiples are getting bigger.

The situation must seem befuddling to Apple (NASDAQ: AAPL) investors. The company's earnings grew 27% throughout 2012, yet its stock slide has seen its P/E shrivel all the way down to slightly north of 10 times earnings. That compares to the S&P 500's P/E ratio that's closer to 17.

Why is Apple trading so cheaply in a market full of companies with little to no growth that trade at much richer multiples? Let's take a dive into Apple's cheapness and what it says about the tech market itself.

Kohl's, Safeway, and... Apple?

The chart below stacks up Apple's cheapness relative to some tech peers. On a P/E ratio basis, it now trades in the same league as Kohl's and Safeway, companies in highly competitive markets with a recent track record of little growth.

Source: S&P CapitalIQ.

Overall, the most startling perspective is Apple trading at a P/E ratio that's in the bottom 10% of the market. A company's P/E ratio is in large part a reflection of what investors feel its growth opportunities are moving forward. Is Apple's growth in the years ahead really worse than 90% of companies?

A crowded marketThe most common cause for concern around Apple isn't that the company won't remain a dominant player in technology. Instead, worries seem to focus on two main areas:

Can the company keep finding new areas of growth? Investors might be used to seeing eye-popping growth rates for smartphones, but the nature of smartphone growth is changing. Last quarter, 89% of phone sales to contract subscribers on AT&T were smartphones. Simply put, in developed markets such as America and Europe with a robust market for high-end phones, most users already have smartphones. That means future growth rates are shifting to areas such as China and India, where low-end phones will be more popular.

Can it keep its margins up? Apple's margins slid from 47.4% last March down to 38.6% last quarter. Competition in areas such as tablets has been mainly on the low end, attacking pricing differences with Apple.

To be sure, concerns about Apple's sheer size are very real. A study out yesterday from researcher NPD showed that the company now commands 20% of consumer technology sales revenues in the U.S.That's more than double the next highest company, Samsung.

However, what many investors seem to overlook is that Apple's sell-off isn't just about Apple itself -- it's about uncertainty over the smartphone industry itself. Apple's chief rival in the space has become Samsung, which shipped 216 million smartphones last year, significantly ahead of Apple's second-place finish of 136 million smartphones shipped. Samsung has become the dominant Android company and left Apple's growth rates in the dust last year. The company grew earnings by 74% in 2012, significantly ahead of Apple's 27% growth rate.

Yet Samsung itself trades for just 8.5 times earnings, a significant discount to Apple's already rock-bottom P/E ratio. If Samsung were in the S&P 500, only 18 companies would have a cheaper P/E ratio than the company. Another large smartphone play, HTC, finds itself at 8.8 times earnings.

It's not you, Apple -- it's smartphonesThe problem with smartphones should be familiar to tech investors. It's a massive growth market with huge potential, but over time competition eats at margins and brings the leaders of the space back down to earth. We saw this in PCs, where Dell was once worth more than $100 billion, but struggled as PC margins eroded over time and is looking to go private now at $24 billion. As growth rates slow in industries, price competition ramps up and margins decline as companies must try to steal market share to find growth.

What's fascinating is that changes in the smartphone landscape such as growth moving to emerging markets seems to have caused quite a bit of uncertainty in the future of the leaders in smartphones but not in the continuing upward trajectory of the mobile industry itself.

Investors seem to be betting that Samsung and Apple won't be able to remain on their lofty perches atop the industry and are instead buying companies that seem set to win no matter how smartphone market share and profits shake out in the coming years. As you can see in the table below, Qualcomm (NASDAQ: QCOM) and Google (NASDAQ: GOOGL) trade for significant P/E premiums to Samsung and Apple.

Company

P/E

Smartphone Position

Samsung

8.5

Leading Android smartphone company.

Apple

10.2

Top smartphone company as measured by profitability. Has own iOS platform.

Qualcomm

17.3

Patent licensing allows company percentage of sales on every data-capable smartphone sold.

Google

24.6

Controls more than 80% of global search market and owns Android platform.

Source: Yahoo! Finance for P/E multiples.

A company such as Qualcomm, which is a proxy for mobile growth since it collects a cut of almost all smartphone sales, investors are willing to pay for growth. Yet, with hardware companies such as Samsung and Apple, little to no growth is priced into their stocks. Taking this out a step further and you can see that two of the mobile companies that have seen the strongest rallies in their share price are Nokia and Blackberry, two companies attempting to turn around their sagging fortunes.

The bottom line is that rather than investing in the smartphone leaders of today, investors are putting their money in "safer" plays to capture industry growth or investing in more speculative plays that could pay off handsomely if today's leaders struggle. The upside to this situation is that if perception changes that Apple's margins and leadership position aren't under fire, there's a willingness to pay P/E multiples in line with the broader market.

If the storyline around Apple changes or it manages to crack some new growth markets with a low-cost iPhone or television, it's not just earnings growth that could push the company higher but also the expansion of its insanely cheap P/E to levels closer to where the market itself sits.

Scared by Apple's plunge? We have expert advice for you.Emotions aside, Apple's growth story is far from over, and the company still has massive opportunities ahead. We've outlined them right here in The Motley Fool's premium Apple research service, and it may give you the courage to be greedy when others are fearful. If you're looking for some guidance on Apple's prospects, get started by clicking here.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

AAPL SOLD 47 billion dollars worth of products 2 quarters ago and last quarter they sold 55 billion worth of products. There is nothing wrong with AAPL, just a lot of stupid people out there chasing the over valued companies like AMZN and many others. Can your brain even fathom how much 13 BILLION DOLLARS MADE IN 3 months is? AAPL has 142 billion in cash. You investors should be buying and one day you will look back and say..." Wow, I was so stupid not to BUY AAPL when it was trading at an 8 PE @450 a share ... And now it sells for $895. Oh yeah, it will happen again. Who is making all the money? AAPL

Apple's previous CEO may go down as the greatest company turn around leader in history. At the very least he will go down as a once in a life time visionary who invented products which created markets.

I'm not sure about the guy who replaced him. Or the company without him. Futher I have heard from more than one source that key people are leaving Apple since Job's departure and therefore even the engine which he built is less than it was.

Because all the reporters on CNBC AND THE MEDIA hate AAPL for having 24 straight quarters of record earnings and 33 straight quarters of increasing their CASH POSITIONS. Oh know... Are margins are going down a little bit , but we are adding 13 to 20 BILLION DOLLARS OF FREE CASH FLOW every quarter. Wall Street and CNBC are pissed because the next closest company makes 1 -2 billion a quarter if they are lucky . AAPL SHOULD BE TRADING AT 1200 A SHARE RIGHT NOW

One issue I have seen very little mention about is Apple's software. The devices are great, but they are losing focus on easy-to-use, intuitive software. The map software change was a famous blunder. It is still terrible compared to Google's version. They made photo sharing more difficult / impossible with iCloud. The newest iTunes is less intuitive to navigate. Safari has far fewer features compared to Chrome. Finally, setting up new devices is more difficult. It took us 3 days to get our new mini iPad rolling. These are all bread-and-butter features that were stellar in the past. If they stay on this path, they cannot hide behind slick hardware.

I don't think Apple, (or their advisers), realize that their stock price scare off many investors. If they would get their price down into the $25 - $50 price range through a stock split, it would then be attractive to common investors.

sigmundk raises an interesting question. Why doesn't Apple declare some splits and trade at a level where many of us can invest? Is there some cachet or corporate benefit related to sky-high (IMHO) share prices?

I really won't bother getting into the APPL past,present or future ...on revenue,product,free cash, competition, P:E or the enormous cash hoard as there are a bunch of very smart fellows among the MF followers who will do a much better job that I.

AAPL was once a no brainer at certain price points and if you were as fortunate as I was to go in with full faith on continued performance...congrats all around.

Now however as an investor @ 450 or thereabouts, it is the lack of real leverage on the invested dollar. So..we buy a round lot of 100 shares to $ 45,000 the stock goes to 550 and the issues at hand get a bit more bleak..we're out with a smart $10,000 nice work !!!

Or we risk the same $ 45,000 more selling comes in, the shorts get more excited, the mutual funds say enough and we're looking at 350..bang out and the loss is a mere $10,000 mere ? Much too much for this guy.

In both of these scenarios we have $45,000 at risk ! Can I do better with that amount of cash,in play, somewhere else, avoiding the inherent risk that AAPL presents these days ? I certainly hope so..........

AAPL has lost the allure of "can't do no wrong"

and has become a risk investment you may not be getting paid for any time soon.

New products ? Great let's see 'em. Get them out with the expected top of the line device and Apple

user devotees in waiting...I will wait as well but for now this is a very ordinary tech vehicle rich in cash but not acquiring yet and on the subject of cash I am keeping mine for now collecting a lousy return..so go AAPL and I'm back in.

The life blood of a tech company is new products. What new product has Apple come out with since Steve Jobs resigned? And I'm not talking about new versions of products. I can't think of a single one. So if that's true and it's new products, I see all the glory going to other companies.

A low P/E only makes a company cheap ONLY if that company is going to be earning significantly more $$$ in the future than they do today. Otherwise, it's a value trap.

I think it's almost impossible for anyone to predict what AAPL's EPS is going to be in 2015. It could be higher that 2012, it could be lower. AAPL is too unique, and their sector is far too competitive and unpredictable.

I think most investors, not speculators, would be wise to throw AAPL in the "too hard" pile.

The question with Apple is how can they maintain their cutting edge with innovation.Remember when Iphone first came out?.Well today, there are numerous smart phones that feels exactly the same.

The launch of every new Iphone while generating buzz, isn't ground breaking anymore.

Look at Palm and BB, they were once industry leaders. It's all about innovation and Apple is a great company at that. Question is, can they always generate the next great thing that no one can live without.

Apple came out with an MP3 player (the ipod shuffle) when the market was already saturated with scads of MP3 players. They wiped everyone else off the map with that stupid little player that wasn't any better than the ones coming out of Korea. The software (itunes) sucked and was difficult to use.

Yet they dominated. Why? Why? Why?

Because the Apple brand is like CocaCola. It's all in your head. It's perception. Coke is no better tasting than dozens of other colas out there if you taste them blind. If you do the test while displaying the logo THEN it tastes better. Too many engineers and left brained people can't understand branding and marketing.

You're not even counting the cash at AAPL when comparing it to the S&P. When you back out the cash it holds (even if you eliminate 1/3 of it to assume taxes on repatriation and/or losses to inflation), the P/E is much lower still.

@dwilh51183: I agree with you completely. Apple is the most valuable, most profitable and most innovative company in history. How could anyone argue with that? If an investor (or hedge fund manager or analyst) chooses to focus on some mundane fact like a margin decrease from 38.1% to 36.9% they will miss out on some money.

Apple is suffering from market saturation on their iPad. Whoever wanted to buy an iPad has now done it and they will not buy another one unless Apple comes up with some amazing new features on future releases. Their smartphone dominance will soon be under threat from Samsung who is coming with a flexible screen model. Apple is slow accepting that this is the next big boom in smart phone. It needs new products or innovative new features on their existing products and it is not coming out with these. Forget ratios, this do not mean anything if buyers do not want their products. This is why Institutional investors have been dumping Apple stocks for a while now and these big boys are responsible for over 70% of the market.

The fact that Apple is not spending their $142 billion in cash trying to acquire growth should tell you that they are very confident! When a company has nothing relevant in the pipeline, that becomes the trigger for new acquisitions.

Apple's setting everyone up for another paradigm shift and we'll just see how the stock does over this year.

The value of any stock is the present value of future cash returned to investors discounted at an appropriate risk weighted rate. The reason no Apple is trading so "cheaply" is because despite being able fund dividends that would support a higher valuation no one trusts their management or board to return investor's money to them. Poor governance = low stock price and it is totally justified.

it' worth noting that a p/eof 10 means a fair value on a dcf basis assuming a discount rate of 10% and no growth in cash flow, ever. so apple and samsung are never going to be able to grow their cash flow, ever? hmm. not too sure about that.

Only if Apple returns that cash to investors. If that cash sits in treasuries until it's wasted on management compensation and failed product lines then the value of Apple is exactly zero dollars. I'm not saying that is what will happen, but the tech industry has pervasive governance issues. Investors need to speak up louder and more clearly to these companies with huge cash hordes. The money belongs to us.

u can skin the AAPL cat a mm ways...but at the end of the day...its still nothing more than a dead cat.

IMO, complex tech companies such as AAPL cant be valued based on traditional valuation metrics, p/e, FCF, etc...I wish I could tell u how, but Im just an ignorant twenty-something stock geek still trying to figure that out...

Margins slid nearly 10% QoQ...pretty steep...if that were to continue, in a yr theyd be below 10% and in line with most other pure-play hardware companies...which if iOS keeps having issues (remember AAPL maps?), is a fair risk.